How ESG is taking over the M&A Process

ESG has become an important consideration in the entire M&A deal cycle. In this article, Dr. Steffen Blase, who’s leading Group M&A at Volkswagen, provides an introduction to the most important ESG considerations in the M&A process.
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ESG is currently a focus topic for corporations, and that is also reflected in M&A: environment, social responsibility, and corporate governance have gained significant importance in assessing new opportunities.

The topic of ESG is a priority for more and more companies, as board members have to disclose to their stakeholders whether they are investing in sustainable and responsible companies.

In this article, we will break down how ESG criteria impact the M&A industry.

More ESG, more M&A

ESG reporting covers the entire value chain of the respective industry.

For the automotive industry, for example, this doesn’t just relate to how batteries are produced, but also how raw materials for batteries are sourced, and how the materials can be recycled in order to optimize CO2 emissions.

Especially in transforming industries, building up that vertical integration is costly, time-consuming, and a challenge.

M&A can be an attractive option to inorganically gain the necessary know-how and assets for integrating the value chain vertically.

Due diligence needs to adjust to ESG

ESG criteria are becoming more and more integrated into the acquisition process. Buyers have become significantly more sensitive to the ESG risks of takeover candidates. As part of the due diligence, they are paying closer attention to this than they were a few years ago.

In addition to an assessment of the corporate governance of the target, additional due diligence areas such as human rights, child labor, fair salary structures, and overall sustainability have gained importance for the successful execution of a deal.

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From my perspective, this is a focus topic for various industries including the automotive industry. For instance investments in natural resources projects are frequently associated with challenging ESG conditions as target companies and projects are mainly domiciled in jurisdictions outside Europe and North America.

And after all, a bad ESG result can also be a showstopper for an M&A project and thus lead to an inefficient use of company resources.

ESG risks reduce the purchase price

Identified ESG risks increasingly need to be addressed post-acquisition. That means  if extensive financial resources are required for the transformation, these should be taken into account when drafting the business case and determining the value creation potential.

Especially in transforming industries, building up that vertical integration is costly, time-consuming, and a challenge.

The termination of an M&A process due to ESG risks is usually only the last resort but is expected to become increasingly common. More often, ESG risks are and will be used as part of negotiations of purchase price or guarantees/indemnities.

ESG impact on financing costs

The financing of acquisitions can also depend on ESG results, not only equity but also debt providers are increasingly focusing on ESG criteria for supplying financial resources.

As a rule, good ESG results reduce a company’s refinancing costs. We made that experience ourselves: With the issue of the first green bond, Volkswagen received more favorable refinancing conditions than with its other, conventional bonds.

Conclusion

ESG criteria already have an impact on the entire M&A process, from sourcing over execution to integration. It is essential that M&A teams familiarize themselves with the new requirements and how to operationally address them, as it will become an integral part of the M&A process in the future.

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